ESCO Technologies Inc (ESE) 2003 Q3 法說會逐字稿

Good day everyone and welcome to the ESCO Technologies, Inc. third quarter conference call. With us today are Vic Richey, Chairman and CEO; Chuck Kretschmer, President and Chief Operating Officer; and Gary Muenster, Chief Financial Officer. And now to present the forward-looking statements I would like to turn the conference over to Pat Moore. Please go ahead.

I would like to remind you if you don't have a copy of the press release, it is available on the web site.

Statements made during this conference call regarding future fiscal 2003 revenues, gains, charges and earnings, the company's ability to meet longer term objectives, the results of planned divestitures, closures, consolidations, relocations, and real estate sales, the outcome of the MSA and other statements which are not strictly historical are forward-looking statements within the meaning of the Safe Harbor provisions of the federal securities laws. Investors are cautioned that such statements are only predictions and speak only as of the date of this call. The company's actual results in the future may differ materially from those projected in the forward-looking statements due to risks and uncertainties that exist in the company's operations and business environment, including but not limited to the risk factors referenced in the press release filed as an exhibit which accompanies Form 8-K filed today. The company disclaims any intent or obligation to update these forward-looking statements.

In addition, during this call, the company may discuss some nonGAAP financial measures in describing the company's operating results. A reconciliation of these measures to their most comparable GAAP measures can be found on the company's web site at escotechnology.com, and the company's Form 8-K and accompanying press release filed today available on the web site under the links investors relations, financial reports and SEC filings.

I will now turn the call over the Vic.

Good morning, everyone. I trust you've all had an opportunity to review the press release. I appreciate there is a lot to digest given the actions announced at the end of the second quarter and last week. Again, this comprehensive set of actions is being taken to improve our near-term results and strengthen our long-term position. After the completion of these actions, we will have a focused and strong core business.

As our projected '03 operational earnings of $2.45 to $2.55 cents per share will suggest we will have better margins, returns and cash flow. Our cost base will also be much improved which inherently puts us in a better competitive position going forward.

With respect to the second half of fiscal '03, the profile between the third and fourth quarters is most likely different than you'd anticipated. As I stated in the press release, this is a result of two timing issues. One in communications. And one in test. I'm confident that in the fourth quarter we will see solid results across all segments of the company's continuing operations. Our fourth quarter outlook is for operational EPS of 60 to 70 cents.

Since I'm sure someone will ask, let me tell you where we're at with our investor-owned utility pursuit. We're still in the pursuit of a number of IOUs which are in various stages of maturity. As has been our past practice, I won't comment on specific projects. We have good technology and market position and we provide customers with a great deal of advanced functionality. The opportunities that this market provides remains significant. While the investor-owned utilities sales process can be frustrating, the co-op market is very active. And as such, our underlying co-op business is showing strong growth.

Gary will now briefly describe the supplemental financial data we've provided and then we'll address any questions you may have.

Good morning. As Vic mentioned and as evident in the press release we have a complex earnings statement for the third quarter in the year-to-date financial results. It was our intent with this release to shed more light on the various reporting events that have occurred and to provide more financial clarity as to what the ongoing operating results were in the periods presented. Our underlying goal was to describe in detail the various items that are impacting our GAAP reported earnings. The magnitude of the detail was necessary to fully understand the core operating results. And was driven by the complexity of the situation.

Rather than recap the press release financials, we can address any questions you have during the question-and-answer portion of the call.

I will provide a brief overview of the definitions used to describe the operating results. GAAP obviously is the required financial presentation and includes all of the reporting events described in the narrative. Adjusted simply removes the amounts noted in the gains and charges section to provide a level of clarity of the operating results including the microsep businesses. Operational takes it a step further and removes the microsep operating results to to provide insight in to the company's core operations on an ongoing basis. As a reminder the microsep businesses will be reported as discontinued operations beginning with the fourth quarter. The tables and related footnotes were intended to provide full reconciliation of the GAAP to operational results.

So I'll be happy to address any of your questions during the Q&A and I'll turn it back over to Vic.

At this time, we'll be glad to take any questions you have.

Thank you, sir. The question-and-answer session will be conducted electronically. If you're using a speaker phone, please make sure your mute function is turned off. We will proceed in the order as you signal and we will take as many questions as time permits. If you do find your question has already been answered you may remove myself by touching the pound key. We'll pause for a moment to give everyone an opportunity to signal for questions.

Our first question today comes from Patrick Forkin of Rockhouse Research.

Good morning. Vic, you made a comment in the release about the timing issue on the AMR side with the retrofit to a new meter. Could you provide some more information on that? I mean, is this something that was destined for PP&L or a different customer? And is it a fit for a solid state meter or -- I'm just struggling with what the issue really is there.

Yeah. Here's what it was Pat. We've been interfacing with a new electronic meter and this is the first one we've interfaced with. And it goes to a broad range of customer. This is going into Puerto Rico, it's going to go into a number of the co-ops. And so our plan had been to get that completed last quarter and start deliveries last quarter. Unfortunately, you know, we were a little delayed in getting that completed. So we are now delivering that to a number of customers. So it was in fact for that sold state meter.

Okay. Is that the Centron [ph] meter?

It is.

Okay. And then so would that account for most of the sequential decline in AMR revenues?

Yeah, really it would account for all of it.

Okay.

Most all of it, I should say.

Okay. And then to follow up from the last conference call that you had, there was a mention of a -- the company -- direct entry into the gas and water markets where you haven't participated before. I was wondering if you would give us some more information as to how you can do that, what the gating factors are. Is it technology? Buying a company to get your entry there and sort of roughly speaking, what you think the timing may be?

Well, a couple of things here. You know, first of all as I mentioned in the last call, we have provided an entry with a gas and a water where we just interface it with our product on a hard wire basis. And what I would like to say today, we also have just received our first order for a short haul RF product which is actually going to send the signal back from the electric meter -- or from the gas meter, water meter, to the electric meter using RF technology versus a hard wire. So we received an order for that this past month and think that that is going to provide us some opportunity for growth.

Now, obviously, that only works in areas where we have the electric meter in place as well. Because we need that power line to send the information from all three meters back to the central location.

Longer term -- and I think this is really the crux of your question. Longer term, we would like to get into more of the gas and water market. That probably would most likely require some type of an acquisition. The timing for that, is probably nine to twelve months from now.

Okay. That's great news on the short haul RF. Is that something that you developed internally?

It is. It is. And I guess, a point of clarification, I threw a time frame out there for the broader range RF. I probably shouldn't do that just because today I can't tell you when we are going to do that. It may be nearer term. It may be longer term. But we need to find the right opportunity. And so I think probably better off not putting a time frame on that. Because, as you know, we try to work really hard to make sure we bring the right partners in-house or the right technologies in-house. So that's going to be the driver rather than the need to get into the market.

Okay. Thank you.

Thank you. Our next question will come from Richard Eastman of Robert W. Baird.

Hi, Vic. Can you maybe just elaborate on the test side of the business. We had some customer delays there, it sounds like. It does look like the backlog is up a few million dollars. Would that be the shortfall? And also the operating margin there, you know, looked a little bit light as well. Is that all overhead absorption? Or what is happening there?

There are a number of things going on in the test business. The back log is up. Part of that is a shortfall. But also, we have had some good progress on the government side. You know, we do a good bit of shielding for the embassies for the U.S. around the world, as well as some of the medical markets have been stronger, for some of the research magnets. The back log is up partially because of the shortfall, but we've had good activity there as well. As far as the margins, part of that is the shortfall in the sales, but also we've continued to make an investment in Asia, as we've talked about in the past. That's coming along well, but it does take some time to get that business up and running.

And the same thing on the AMR side of the business, in terms of the margin itself, is that, again, absorption in volume? You mentioned mix a little bit, but --

It really is the mix. And I hate using the word "mix" because people use it too often, but the reality is, we've had a large number of CMI meters, commercial industrial meters in our mix in the third quarter. And they do carry a much lower margin than our traditional product. So that did have an impact on the margins in that segment.

So as we look out into the fourth quarter, is there any reason not to model a more normalized rate?

There is no reason not to do that.

Okay. Thank you.

And from JMP Securities, we have our next question from Steven Colbert.

Good morning, Vic. My favorite topic, here. I would like to ask you about the filtration margins.

Right.

It looks like if I was -- add back the loss that you talk about in the first half from the microsep operation, margins would have been north of 10% in the first half, close to 11. It looks like in this quarter, they fell to slightly under about 9 % picking up the microsep operations once again. Could you just tell us a little bit about why the margin weakness in the quarter versus the first half numbers?

Sure. The primary drivers there are some of the operating expenses that we're experiencing, things like Workers' Comp, overall insurance, health care, all of those things are up. Some of the things we're going to -- doing to offset that, moving from Puerto Rico to Juarez. We're consolidating some of our existing facilities. So everbody's fighting the same battle as you well know. Expenses are going up. But I would like to say, we recognize that we're going to do something about it proactively.

Why were they so much worse in the third quarter than what you saw in the first two quarters?

It was primarily -- the big driver there was Workers' Comp. We had some unusual circumstances there which really drove that.

Can you quantify that?

I don't think it is appropriate that we provide that level of detail. But I would just say that is the primary driver.

And just as a follow-up question, can you help us to understand, it sounds like -- looks like you're looking like you're expecting margins to get back to where they were before, again, excluding the microsep operations in the fourth quarter. Was that built into your guidance?

Yes. And that's starting point going forward I assume to fiscal '04 then? Right.

Thank you. I'll get back into cue.

Thank you.

Our next question will come from James Gentile from Sidoti and Company.

Good morning, gentlemen. How are you?

Good. How are you?

Not bad. Looking at -- I guess just something I wanted to ask you a question regarding the communications business, the securities systems business is, there any reason to believe we'll be getting that any incremental growth from that business, you know, over the next couple of years? Is the potential to be a 20 million business over time? Are you guys focusing on that at all?

We're focused on the business. I mean, I think it is premature to talk about the potential side. We think there is good opportunity there or we wouldn't continue to pursue it. We do have a focus there. We have a good product. We think it has good long-term potential.

And then looking at your fourth quarter revenue guidance for the communication segment, the 35 to $37 million, do you have any idea how much of that is Pennsylvania?

Of course we do. I don't think it is appropriate --

it is not appropriate. Okay. Fair enough.

That level of detail.

Okay. Because it seems as if it may be fluctuating quarter by quarter.

It has some. And certainly as we talked about in the past, we probably have topped out there. And the revenue that's been provided by that project is down this quarter certainly from what it was last quarter.

So how much in incremental growth then should we see from your co-op business for the fourth quarter then?

I think -- I think if you look at the backlog, I think that is kind of broken out. What we did do is break out the detail project from the --

Right. So anything meaningful outside the PP & L could be construed as co-op business then?

Yes, at this point. We do get some follow-on business, as you know, from the other investor in utilities from time to time, but the majority of that could be the co-op business.

Thank you.

And before we take our next question, I would like to remind everybody to press star one if you do have a question today. Also please limit yourself to one question and one follow-up question. We'll move to Steve McNeil with SSR & M.

Good morning. Just a question on cash. I see that we -- just trying to -- well, I wanted to revisit the unusual items as it relates to the cash balance. It looks as though the only outstanding item that would be added to cash is the Watman MSA situation. Is that correct? Or I think Puerto Rico may not be in there as well, the proceeds from the potential sale of that facility.

That's correct, Steve. Excuse me. Obviously the writedown on the building was to take it down to it's -- from book value to net realizable value. But upon the completion of the sale of that facility, that will obviously be cash positive when we complete the transaction and collect the cash. We're not expecting that cash in the fourth quarter obviously. And also the proceeds that would come in when we actually divest the microsep businesses at the projected price would obviously be a cash positive downstream as well.

Those are the only two outstanding items, if you will, as it relates to proceeds.

And watman as well, so actually three.

Okay. And then on inventories, they've increased about $12 million from year end. And I was wondering if you could comment on what segment that increase is from.

Yeah. There is really three issues that drove the inventory as we've talked about in the past. Part of it is PPL. We want to make sure we don't disappoint that customer. Also with the move of some of the plant that we're going through now, we're building inventory. We had to make sure we're able to satisfy customer requirements. So a move from Puerto Rico to the other facilities on the filtration side. And then to actually take some business out of Juarez and move it back to parent business as well. So we're building inventory for that.

And then the third piece of that, with this delay of the test deployment, some of the projects actually being done in the fourth quarter and beyond versus the third quarter, we had already built some of those inventories to be prepared, satisfy those requirements. And then as that has slipped that inventory has remained.

So have you built any stock inventory within communications in anticipation of additional IOU contracts?

Not specifically for that. We have some inventory that could be utilized. We keep some level of inventory that we can utilize for the co-ops of if we had another investor in utility service we could use it for that as well. We do keep some level of inventory. Particularly for the co-op customers, because they can be very quick turns. So in particular we keep a number of substations available for deployment.

Okay. Thank you.

We'll move next to Paul Connally with Southwell Partners.

Yes, good morning. Actually this is Wilson Jaeggli [ph] stepping in for Paul. A question here on the AMR, with AMR such an important portion of operating income, and with PPL, as I understand it scheduled to start a decline here in the December quarter, and that decline to continue through I guess all the way to the June quarter, how are you going to make up for that, if that is such a significant portion of the AMR division?

A couple of things. Specific to the communication segment, I mentioned our co-op business has really picked up. That's going to fill in a good bit of it. Certainly our hope is to have another investor on utility. I don't think we have to count on that -- or can count on that. The co-ops are going to help out a good bit. And some of the actions that were taken around the rest of the company are going to improve the rest of our operating results around the company. So we aren't as dependant upon the communication segment as we have been in the past.

Do you see, with the electrical utility industry in general -- and I don't know how to exactly classify it, but they are having their own specific problems we're all aware of. And secondly with no real announcements of large AMR contracts out there, what do you see the volatility or the chances of getting some significant contracts?

There is still a lot of activity. We're in discussions with a number of people and it really does come down to timing, I believe. There are utilities, and there are such a large number of investor-owned utilities and they are not all in as bad a shape as we might believe. There are certainly some that are having issues. But I think there are enough out there that our opportunities are still good. And then the other thing I would say, there are some -- in the current tax bill, if it passes, there are some things within that that would make it more advantageous to utilities to make this type of decision.

To make sure I understood you, you believe you can maintain the growth in the AMR division by incremental growth coming out of co-ops? Is that fair or too gross of a statement?

I think it is probably a little bit too gross of a statement. I don't know that we're going to be able to back fill that in total. What I am saying, maybe it is not going to be the cliff that maybe it would have been. We would have seen six or nine months ago had the co-op business that picked up as much. In addition if you look at ESCO's overall operating performance, I think with some of the decisions that we have made and some of actions that we've taken, the underlying performance of the other segments are going to improve to help make us less dependant on the communication segment.

Would it be fair to say, to maintain your current rate of growth -- and you know you've had a wonderful rate of growth here in AMR, that you would basically need one contract to replace PPL and then an additional contract to fund the growth?

I think if we had another investor-owned utility that we would be back on the growth curve that we've seen in the past.

Just another one. Well, congratulations you've really put a tremendous record together here in the face of a lot of economic turmoil out there. So best wishes.

We have time for one more question.

Thank you. Our final question today will come from Steven Colbert with JMP Securities.

Just this last topic, how much of your backlog that you have in that segment of 136 million is represented from the PP&L contract?

Yeah, I don't think we can provide that level of clarity. Unfortunately. I think you can go back and if you look at what we've done historically, you should be able to get to that.

I'm not sure you've broken it out for us. Just roughly what you have left on that contract. Which is what I would estimate. And just one other point here, is that, it looks like, if my math is right, you're looking for a loss this year in the microsep operation of around 45 to 50 cents. You lost around 23 or so in the first half. Is that about right? And 8 cents in the third quarter? That's $4.9 million in the first half and $1.6 in the third quarter.

Yes, I think that's accurate, Steve.

Why, then, is there a big loss stepping up in the fourth quarter to 16 cents?

On microsep?

Yes.

Well, I think the impact of the SRT acquisition, I think, is a big part of that. So I think when you see just the fundamentals, there, I -- it is just really an issue of further perpetuating why this action is necessary.

So losses came down the third quarter. But it didn't go back up in the fourth quarter. It looks like.

That's the way the profile currently lays out.

Okay. Thank you.

And that concludes today's question-and-answer session. I would like to turn it back over to our speakers for additional or closing remarks.

By way of summary, I feel good about the operating results the company will achieve in '03. More importantly as a result of the actions we've undertaken for better position for success in '04 and beyond. We look forward to building off our core businesses, both the organic growth and with the addition of new partners in our core market. Thanks for joining us today.

That does conclude today's conference. We thank everyone again for their participation and have a great day.